Why a capital gains tax increase hurts us all
BY JULIA ANDERSON
Those of us who are retired should pay attention to the proposed tax increases on capital gains income being promoted both by states (Washington state) and by the Biden Administration.
Even though President Biden says his capital gains tax increase will only affect the wealthy, not you, don’t believe it. Any change in tax law affects markets top to bottom, changes investment strategies and could generally dampen enthusiasm for capital investment at all levels.
Retirees are living on investment savings --- CDS, stocks and bonds -- and income generated by U.S. stock markets and underlaying resilient economy. For the past ten years, it has been a good ride, up 13.6 percent a year. Our portfolios are looking healthy.
Here’s the deal. Even though only those with $400,000 of capital gains “profit” or more annually would pay higher capital gains taxes up to 43.4 percent (double the current rate), the higher tax rate will hurt markets…our markets.
Capital gains tax (15 percent for middle income investors, 20 percent for the wealthy) have been used by government for decades to deliberately create incentives for investors who put money into new business ventures and into corporate stock. This tax strategy supports new enterprise, grows overall employment, and strengthens the general economy. Middle-income retirees benefit from this economic momentum. When these stocks are sold, up to now, we pay a lower income tax on the gain (or profit). Here’s a chart:
2021 capital gains tax rates:
15 percent for those with taxable income of $40,451 to $441,450.
20 percent for those with taxable income $441,451 and more
2021 ordinary federal income tax rates - married, filing jointly.
12 percent for those with taxable income from $19,751 to $80,250
22 percent for those with taxable income of $80,251 to $171,050
Raising capital gains taxes punishes businesses seeking capital investment to support expansion. At the same time, higher capital gains tax punishes investors by reducing income. That means fewer of their discretionary dollars are spent on housing, cars, consumer goods, dining out -- all the sectors that need support as we recover from the pandemic. The higher tax puts a damper on the entire U.S. economy.
Meanwhile, wealthy Americans are already strategizing for how to avoid higher capital gains taxes. Wharton School of Business researchers conclude that tax avoidance could cut $900 billion from the estimated $1 trillion the Biden Administration says it will collect in new capital gains tax money to pay for infrastructure and more. Do they think the wealthy are stupid? An easy alternative for them? Tax-exempt municipal bonds.
By the way, money coming out of your tax deferred retirement (401(k) and IRAs) accounts is taxed as ordinary income at a rate commensurate with your federal income tax bracket. An increased capital gains tax applies only to income from shares invested outside of a retirement plan.
Expert analysis in numerous studies on capital gains taxes, however, says that a rise in the capital gains tax rate reduces wage growth by dampening investment in corporations looking for new capital to expand. At the same time, the tax reduces revenue growth for governments simply because people will be more reluctant to sell stock and thus pay the higher tax. According to the Congressional Budget Office for each 1 percent increase in the capital gains rate, there is a 1.2 percent reduction in tax realizations (collections). That’s because rich investors will hold on to investments longer and look for other ways to avoid taxes.
There are other aspects in the Biden tax proposal that have estate planners and their clients worried. Those include changes in inheritance tax regulations that will make it harder to pass on farms and businesses to a new generation. But that deserves a separate column.
Many states also have capital gains taxes or are implementing them. California leads the pack with a rate of 13.3 percent. Among other top five capital gains tax states are Hawaii, (11 percent), New jersey, (10.75 percent), Oregon, (9.9 percent) and Minnesota, (9.8 percent).
Washington state’s Legislature has approved a bill (2021) that creates a new capital gains flat tax of 7 percent on the long-term gain from the sale of stocks, bonds, and other high-end assets more than $250,000 for both individuals and couples. For details, click here.
The tax exempts real estate, retirement accounts, agricultural land, and family-owned small businesses. It still is a new tax on income in a state that up to now has not had an income tax.
Meanwhile, the Biden administration is proposing a top tax rate on capital gains of 43.4 percent, up from the current 23.8 percent. That means on every $10,000 of stock sold, the tax would total $4,340, up from $2,380 with the lower rates. The editorial board of the Wall Street Journal calls the idea, “the dumbest way” to raise taxes.
The bandwagon to raise capital gains taxes is pitched as a tax on “rich people” who should “pay their fair share.” This ignores that fact that the top 50 percent of all taxpayers already pay 97 percent of all federal individual income tax. The top 1 percent pay 40.1 percent. The bottom 90 percent of taxpayers combined pay 28.6 percent of all federal income tax. In 2019, 46.6 percent of U.S. households with an annual income of between $40,000 and $50,000 paid NO income taxes at all. Click here.
The Biden Administration says only 500,000 taxpayers would be affected by the proposed tax. The issue is not about who pays but the longer-term impact on markets in terms of slower investment and slower economic growth that will affect us all.
It’s politics, not common-sense economics that is driving the capital-gains campaign. Tax incentives related to capital gains have been on the books for more than 50 years. They work.
Women and good financial credit: You may need it sooner than you think
BY JULIA ANDERSON
Don’t wait until you are widowed at 67 to build a credit history. When you lose a spouse to death or divorce, (or never marry, for that matter) creditors may view you differently, as a bigger credit risk.
It may come as a surprise for many women that access to credit in the form of credit cards, a car loan or mortgage refinance may be a bigger challenge, when single and financially independent. The pandemic has been a set-back.
Last year, some women lost income, increased debt, and put less into savings. All of this can undermine your credit standing. According to Experiena.com, a major online credit score service, 2.7 million women left the workforce in 2020 as compared with 1.7 million men. Female participation in the workforce is now the lowest since 1988, the report said.
Married or single, women need a good credit history in their own right. It is another aspect of planning for the unexpected…an unplanned death, an unplanned divorce, a serious accident, or illness that can affect finances and the ability to borrow.
What is good credit?
Establishing good credit means that you pay bills on time. It means not taking on more debt than you should related to your income. Good credit means not having filed for bankruptcy in the past seven years, not having been foreclosed on or had a debt sent to a collection agency.
Lenders use your income and your bill-paying history to establish your credit score, which in turn helps determine if you are a good credit risk and likely to pay back a loan over time.
Financially independent women know that a good credit score helps with credit cards and loans, but also with lower insurance rates and when applying to rent an apartment. Yes, you can live without a credit score but that might mean carrying around more cash or going through a bigger hassle is securing a loan.
What is a credit score?
There is no one credit score, but a higher score or scores usually means it will be easier to get a loan or rent an apartment.
“Any credit score depends on the data used to calculate it, and may differ depending on the scoring model, the source of your credit history, the type of loan product, and even the day when it was calculated,” says the federal Consumer Financial Protection Bureau. “Most credit scores range from 300-850.”
The good news is that in 2021, men and women now share the save average national credit score of 705. “This is a 1-point increase for women from 2019 and about a 10-point increase for both groups from 2015,” said Experian.com, an online credit rating service.
How to build good credit
Establishing good credit takes time, maybe several years, as you create a bill-paying record. Here are tips from the federal Consumer Financial Protection Bureau for how “get and keep a good credit score.”
Pay your loans on time, every time.
Don’t get close to your credit limit on a credit card. Only apply for the credit you need. (According to Consumer Financial Protection, if you apply for a lot of credit over a short period of time, it may appear to lenders that your economic circumstances have changed for the worse.) Keep your credit card debt below 30 percent of your limit.
Avoid high interest rate charges by paying off your credit card(s) every month.
Fact-Check your credit scores. (You are entitled to a free credit report every 12 months from each of the three major consumer reporting companies – Equifax, Experian, and TransUnion. To do that visit AnnualCreditReprt.com or call 877 322 8228 to get a report)
Avoid web sites that offer free credit report assistance. For most, it’s free, only if you buy their products.
Unlike Dave Ramsay, I believe there is “good” debt but that is debt you can pay off on time. I never believed lenders who told me that based on my income I could afford xxxx amount of mortgage debt. For me, the amount was about half what they said I could borrow.
Establish a credit card in your own name, separate from a joint family account. While married, I’ve kept my own name on credit cards and my home mortgage loan. When refinancing your home mortgage, do it in your own name, separate from a new married partner. Otherwise, he becomes joint 50 percent owner on the title.
In a divorce, make sure your spouse’s aggressive attorney does not put a lien on your house without notice. Then this attorney forgets to remove the lien in the divorce settlement. Only three years later do you find out about the lien when you can’t refinance your loan unless it is removed. That means tracking down your ex-spouse, a frustrating and painful experience.
A recent survey by creditsesame.com, an online card and loan tracking service, showed that 55 percent of women say, “they were never taught the best ways to manage credit and about a quarter would give themselves a failing grade when it comes to their current understanding of credit scores.” Tell your granddaughters about the good and bad of credit cards and about how to get and keep good credit.
What to do if you have BAD credit
Credit counseling can help if you have bad credit, are behind with bill paying or have defaulted on a loan. Credit counseling services can help you organize a debt management plan to pay down debt. Some of these services are free, some are not. Read the fine print before signing an agreement.
For more: Go to www.consumerfinance.gov, search for credit counseling services. Topics include how to choose a credit counselor, counseling service fees and agreements. Or search YouTube for my Smart Money piece on credit and credit counseling services. Click here.
It wasn’t long ago (early 1970s) that women could not apply for a loan in their own name, not gain a credit card in their own name without a male co-signer or make larger down payments on mortgage without a co-signer.
The 1974 Equal Credit Opportunity Act prohibited creditors from such discrimination based on race, color, religion, national origin, sex, age, and marital status. It took years of lawsuits and complaints for lenders to comply. I know because in the late 1980s when divorcing, I asked my bank to reissue my credit card using my new name. It refused. I was shocked. I had the same job, the same credit history and same savings and checking accounts.
I then applied to a national Mastercard issuer, got a new card, and changed banks.
A Quote: “If you have debt, I’m willing to bet that general clutter is a problem for you too.”
-- Suze Orman, American financial advisor, book author and podcast host. (1951 - )
BY JULIA ANDERSON
Retirees are told to pay off their mortgage before they leave their jobs or at least soon after. But should you? Does it make financial planning sense? Here’s my analysis of why or why not paying off your mortgage is a good move.
Pluses first. You eliminate a big monthly loan payment, which increases your monthly income. You don’t have to worry about rising interest rates, if you have a variable or adjustable-rate loan that could take a bigger bite out of your income, if the Fed raises interest rates. You increase your net worth by eliminating debt. It feels good to pay off the house loan and be debt-free as you head into retirement.
But where will the cash come from to make this move? Will it leave you “cash poor” in case you face a financial emergency such as an early retirement buyout, a major illness or accident or an unexpected need to buy a car or one for your grandchild?
Paying off a mortgage is more complicated that it might first appear. YOU WILL NEED A CALCULATOR AND POSSIBLY AT TAX ACCOUNTANT TO DECIDE WHAT’S BEST FOR YOU.
Why paying off a mortgage is NOT a good idea
With interest rates at historic lows, carrying a mortgage loan with a cheap 2.5 percent rate is not expensive. A 30-year fixed loan on $150,000 at less than 3 percent costs less than $1,000 in a monthly payment. On a $350,000 loan the monthly cost is $2,000 or less per month. It’s cheap money. You might want to put your cash to work elsewhere.
You get a deduction on your federal income tax for interest you pay annually on the loan. That reduces your taxable income. On the other hand, you no longer are making those interest payments, which will save you thousands over the life of the loan.
You might do better by investing the cash you would use to pay off the loan. Over the past 10 years, portfolios invested 60 percent in stocks and 40 percent in bonds have averaged roughly a 10 percent annualized return. With a $100,000 initial investment plus $1000 more a year invested over 10 years in stocks, your nest egg will grow to $276,905. BUT there are NO guarantees this track record will continue if interest rates go higher.
Once money is sunk into a house it is “illiquid.” In other words, you can NOT easily tap the equity in your house in an emergency. However, this could be a forced savings plan if you are not a saver.
But again, THERE ARE PLUSES: You are debt free. You eliminate a big monthly expense. You don’t have to worry about rising interest rates if you have a variable or adjustable loan. You are more financially secure without the debt. You lose the tax deduction but you gain way more income from NOT having a loan payment!!
Take These Steps Before You Decide
Understand the trade-offs between paying off the loan and eliminating your mortgage payment vs. the tax write-off benefit and/or investing your cash elsewhere for the long-term.
Run some scenarios comparing household income expense and savings, if you pay off the loan and the changes in your tax profile, if you pay off the loan. How much will you save in loan interest payments? Interest saved on a $350,000 loan even at 2.5 percent over 30 years will total nearly $148,000.
How will you use the “new” money if you eliminate the loan payment? Will you still have cash for unexpected emergencies? Get a tax professional to help you.
Look at how you would invest the cash that you might use to pay off the loan but instead invest it for the long haul. What kind of earnings can you expect over the next 10 or 15 years. Will you still have cash for emergencies? Build up an emergency fund (in cash) to cover household expenses for at least six months.
Do not tap your long-term tax advantages retirement funds – 401(k) or IRA to pay off your mortgage loan. You will need that tax-deferred nest egg for the long haul. Taking money out early undermines your compound reinvestment wealth-building strategy.
How about a compromise? Consider making “early” payments on your mortgage loan instead of an outright payoff. You can pay down the loan faster, reducing the time to pay off the loan. Invest the rest of your money a 60/40 stock-bond fund.
Don’t take an unexpected tax hit by selling investments to assemble the cash to pay off a mortgage. Those sales could bump you into a higher income tax bracket… 24 percent vs. 32 percent on taxable income (using current tax law).
Celebrate your decision!
If you pay off your mortgage, celebrate your decision. Your are debt-free, your net worth increases and your monthly income goes up. You will always wonder if you made the right call but stay focused on how good you will feel if there’s a stock market crash or interest rates go up.
Going forward: Take the “new” money in the amount of your former mortgage payment and stash it in a savings or investment account…. a PAINLESS MOVE that will build long-term wealth.
AARP - Paying off your mortgage. click here
AARP mortgage calculator. click here
WSJ “Should Retirees Pay Off Their Mortgage or Invest the Money?” click here.
Bankrate.com "Does it make sense to pay off your mortgage early? click here
Dave Ramsay: "Why Should I pay off the Mortgage?" click here
Bloomberg (For those 40 and under) “The Opportunity Costs of Paying Off Your Mortgage Early,” click here.
By Julia Anderson
Women interested in money management, long-term investing and building a retirement portfolio should see 2020’s pandemic stock market ups and downs as a great lesson. As one analyst put it recently in the Wall Street Journal, “it felt like something different, but it wasn’t.”
He meant that when Covid-19 infections swept the world, shutting down the global economy, killing the travel industry, closing restaurants, and most everything else, it felt like something new, something awful. Panic set in, investors felt the fear and stocks sold off in March 2020 by 34 percent. That’s a bear market.
But 2020 taught us that what feels new is mostly not.
Here are the lessons we RELEARNED!
Lesson No. 1 Seasoned Investors Stay the Course
Those who sold off stock investments in the 2020 panic were then faced with a tough decision – when to buy back in? Many didn’t. Several friends told me that they were bailing out of stocks. They were scared by what might happen next. As one said, “I want to be able to sleep at night.” Fear was in the air as we hunkered down, buttoned up and began hoarding toilet paper and hand sanitizer.
But what happened? This bear market sell-off was short-lived. Like other market selloffs. It ended sooner than later as the federal government cranked up the money printing press and began rescuing the economy.
While “all bear markets are inherently different, the common thread is that they always end,” said Peter Lazaroff in a WSJ report. “Investors must be willing to lose money on occasion – sometimes a lot of money – to earn the average long-term return that attracts most people to stocks in the first place…. if you can be a buyer in times of fear, your chances of earning above average returns improve,” he said.
Starting in late March 2020, the S&P 500 began a recovery that continued into 2021. By the end of the year, stocks were up 16.26 percent over 2019. That’s well above the annual average return of around 7 percent.
Hanging in there was among several lessons learned again by investors in 2020. In fact, buying when others are selling is almost guaranteed to reward the long-term investor.
Lesson No. 2 An Emergency Fund is a Great Idea
A survey of investment managers by the Wall Street Journal ranked putting cash into an emergency fund as a top priority money tip. An emergency fund means that the blow of an unexpected layoff can be modified.
Emergency money will save you from expensive credit card debt until unemployment checks kick in and you can figure out what to do next. At least six months of cash. Everyone tells us this.
Lesson No. 3 You Need a Will
At sixtyandsingle.com we have preached this forever. Since covid-19 began taking lives, it is even more clear that people need a will no matter what age they might be. A will spells out how you want your assets distributed. It makes sure your beneficiary designations are up to date on a 401(k)-retirement savings plan. A will can tell your heirs how you want your belongings distributed. This is a long-term but urgent item on your to-do list. Make a will!
Lesson No. 4 Stay Loose with a Retirement Plan
According to Maddy Dychtwald, co-founder of Age Wave in San Francisco, an estimated 81 million Americans will see their retirement timing affected by the pandemic. In other words, they won’t retire when they originally planned. People are putting off retirement for an average of about three years, an Age Wave survey said.
Working longer into your 60s is not a bad thing…more time to recover, save and invest, more time to put off taking Social Security and more time to enjoy the job. Many women I know are working because they love the action and see no reason to stop.
Lesson No. 5 Markets go up, and down. That's Okay
Surveys show that women can be more easily scared out of stock markets and are generally more conservative investors. They hate seeing the value of their investments decline when markets sell off. They tend to put more of their savings in low-earning money market funds at a time when they should be in equities. “A diversified portfolio that you can stick with regardless of the market environment should be the cornerstone of everyone’s investment strategy,” Jeff Mills, chief investment officer of Bryn Mawr Trust, told the WSJ.
The year 2020 taught us AGAIN that nothing stays bad forever, that what might feel new and scary is really a variation on what we’ve seen before. Disciplined investors hang in there for the long haul by riding out the drops and benefitting from recoveries..
15 Personal-Finance Lessons We can All Learn from in the Year of Covid-19. Click here
Wills and Trusts: Needed Now More than Ever Click here.
Life and Money Lessons from the Pandemic Click here
BY JULIA ANDERSON
Grandparents, especially these days, are looking for ways to help their kids and grandkids get ahead financially.
A simple way to give them a long-term financial boost is with a Roth Individual Retirement Account -- grandchildren especially. You can do this before they turn 18.
As we know, time is money. Money going into a Roth IRA for a kid, grows federally TAX-FREE until their retirement. For my 16-year-old grandson that will be 2069. A Roth IRA (for a child under age 18) can be opened and managed by an adult…parents, grandparents, even a friend of the family with a maximum $6,000-a-year contribution.
There’s one BIG CATCH: The money going into a Roth IRA for a kid under age 18 MUST BE EARNED INCOME. In other words, the kid must have a part-time job or be self-employed doing something like babysitting, dog-walking, yardwork, snow-shoveling or window washing. Income from these activities is “earned income” and can be verifiable.
As the grandparent, you can match this amount of earned income with a Roth IRA contribution. For example, if she/he generates earned income from a summer job totaling $800, you can put $800 in her/his Roth IRA custodial account. IRA contributions can not exceed a minor’s earnings. So, the earnings come first, then the IRA contribution. There is no minimum investment.
Why bother with what will likely be small contributions? Maximum contribution: $6,000 a year. But like I said, time is money. For example:
A $1,000 one-time contribution with reinvested earnings that grow an estimated 7 percent a year for 20 years will result in $3,870 in savings.
A $1,000 contribution every year for 20 years with reinvested earnings of 7 percent a year will grow to nearly $50,000.
A $2,000-a year-contribution over 20 years with 7 percent earnings results in about $95,000 in the Roth account.
Now, let’s double the timeline to 40 years.
$2,000 a year contribution over 40 years at 7 percent will generate a future balance of nearly $450,000.
The lesson here is that the more money you invest and the earlier you invest it adds up to a whopping increase in the end result after 40 years of saving and investing. The more money that goes in early, the better.
And when the grandchild starts withdrawing money at retirement, it will be TAX-FREE. They will have you to thank.
FYI: The current federal Roth IRA contribution limit per year is $6,000. Also, there are fewer penalties for withdrawing the money early, if needed for a down-payment on a house.
Where to invest the money?
At this young age and on into their early 40s, the money should be invested in aggressive dividend-producing stock funds because there will be time to make up for any market downturns as they age into their 50s and 60s. More time means more reinvested growth of the investment inside the account.
Investing is better than saving since reinvested dividends in stock accounts outperform any savings account by 10 times over in today's low-interest rate environment.
Best Reasons for a Roth IRA for your Grandkid
A tax-free or tax-deferred investment demonstrates the miracle of compound interest over time. A Roth IRA can be set up online with no commissions or account fees.There’s no age restriction but the child must have earned income.
A Roth IRA is more flexible than any other retirement account because contributions can be withdrawn at any time with no penalty and can be used for more than retirement. But the ultimate goal should be retirement.
At age 18, in some states 21, the child becomes the owner of the Roth IRA account. You can still help them make contributions.
Nerdwallet, "Why your kid needs a Roth IRA," click here.
Fidelity, "Roth IRAs for Kids," click here.
U.S. News, “How to Set up a Roth IRA for Your Child.” Click here.
Motley Fool, “Can You Open a Roth IRA for Your kids?” Click here.
Dave Ramsey. "How Teens Can Become Millionaires." click here.
I meet women all the time who face job and money transitions and who want to do them right. It’s about building confidence and taking charge of the future. This is your money. No one cares more than you do!
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